Intended Learning Outcomes for these individual exercises
This next week…it is all about risk assessment NOT predicting the future. It’s impossible to determine today if and when MedStar will choose to exercise its early termination clause. All that we do know is that the risk is real. This week we will use the FO model to evaluate the impact of an early termination of this key tenant on the targeted returns.
Ask yourself and answer…at the stated purchase price and assuming MedStar invokes the early termination clause…can you survive (pay more equity into the deal to service debt and pay TI’s and LC’s) this downside scenario? If the answer is “yes” then how will your lender view this risk when sizing the loan? You may decide based on this analysis to change your offering price or adjust your repositioning plan for FO. Finally, what is the impact on your JV structure relative to this risk?
Many questions to answer this week and it all starts with the rollover tab. As always own the model and verify ALL formulas. HINT: The MedStar lease is also posted on the course site and reading the lease could shed some light on your risk assessment for this key tenant.
We are moving into the segment of the class where we are spending most of our time on how to structure the purchase price to meet our intended outcomes.
1.) Two projects are being considered with the following return characteristics:
State of Economy Probability Estimated BTIRR Estimated BTIRR
Optimistic 20% .15 .20
Most Likely 60% .10 .15
Pessimistic 20% .05 .05
Considering the risk and return estimates, how can you compare these two investments? What would you suggest or recommend based on your observations and calculations? (Hint: refer to Chapter 13).
2.) Where are the following rollover costs reflected in your DCF model relative to NOI? When answering make sure to mention all rollover costs.
• Downtime (Gross Income minus downtime is an interim step before calculating Effective Gross Income) which is the loss of income between the time a tenant stops paying rent and the time that a replacement begins payment of its rent. This extends to tenant reimbursements as well.
• Free rent for new tenants (next deduction after downtime).
• Tenant Improvements and Leasing Commissions (shown below the line of NOI).
3.) What is the impact of the rollover costs on the overall property value?
a.) For the DCF analysis?
b.) For the Direct Cap Method